This is the accessible text file for GAO report number GAO-08-223
entitled 'State and Local Government Retiree Benefits: Current Funded
Status of Pension and Health Benefits' which was released on February
28, 2008.
This text file was formatted by the U.S. Government Accountability
Office (GAO) to be accessible to users with visual impairments, as part
of a longer term project to improve GAO products' accessibility. Every
attempt has been made to maintain the structural and data integrity of
the original printed product. Accessibility features, such as text
descriptions of tables, consecutively numbered footnotes placed at the
end of the file, and the text of agency comment letters, are provided
but may not exactly duplicate the presentation or format of the printed
version. The portable document format (PDF) file is an exact electronic
replica of the printed version. We welcome your feedback. Please E-mail
your comments regarding the contents or accessibility features of this
document to Webmaster@gao.gov.
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed
in its entirety without further permission from GAO. Because this work
may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this
material separately.
Report to the Committee on Finance, U.S. Senate:
United States Government Accountability Office:
GAO:
January 2008:
State and Local Government Retiree Benefits:
Current Funded Status of Pension and Health Benefits:
GAO-08-223:
GAO Highlights:
Highlights of GAO-08-223, a report to the Committee on Finance, U.S.
Senate.
Why GAO Did This Study:
Pension and other retiree benefits for state and local government
employees represent liabilities for state and local governments and
ultimately a burden for state and local taxpayers. Since 1986,
accounting standards have required state and local governments to
report their unfunded pension liabilities. Recently, however, standards
changed and now call for governments also to report retiree health
liabilities. The extent of these liabilities nationwide is not yet
known, but some predict they will be very large, possibly exceeding a
trillion dollars in present value terms.
The federal government has an interest in assuring that all Americans
have a secure retirement, as reflected in the federal tax deferral for
contributions to both public and private pension plans. Consequently,
the GAO was asked to examine: 1) the key measures of the funded status
of retiree benefits and 2) the current funded status of retiree
benefits. GAO analyzed data on public pensions, reviewed current
literature, and interviewed a range of experts on public retiree
benefits, actuarial science, and accounting.
What GAO Found:
Three key measures help to understand different aspects of the funded
status of state and local government pension and other retiree
benefits. First, governments’ annual contributions indicate the extent
to which governments are keeping up with the benefits as they are
accumulating. Second, the funded ratio indicates the percentage of
actuarially accrued benefit liabilities covered by the actuarial value
of assets. Third, unfunded actuarial accrued liabilities indicate the
excess, if any, of liabilities over assets in dollars. Governments have
been reporting these three measures for pensions for years, but new
accounting standards will also require governments to report the same
for retiree health benefits. Because a variety of methods and actuarial
assumptions are used to calculate the funded status, different plans
cannot be easily compared.
Currently, most state and local government pension plans have enough
invested resources set aside to keep up with the benefits they are
scheduled to pay over the next several decades, but governments
offering retiree health benefits generally have large unfunded
liabilities. Many experts consider a funded ratio of about 80 percent
or better to be sound for government pensions. We found that 58 percent
of 65 large pension plans were funded to that level in 2006, a decrease
since 2000. Low funded ratios would eventually require the government
employer to improve funding, for example, by reducing benefits or by
increasing contributions. However, pension benefits are generally not
at risk in the near term because current assets and new contributions
may be sufficient to pay benefits for several years. Still, many
governments have often contributed less than the amount needed to
improve or maintain funded ratios. Low contributions raise concerns
about the future funded status. For retiree health benefits, studies
estimate that the total unfunded actuarial accrued liability for state
and local governments lies between $600 billion and $1.6 trillion in
present value terms. The unfunded liabilities are large because
governments typically have not set aside any funds for the future
payment of retiree health benefits as they have for pensions.
Figure: Percentage of State and Local Pension Plans with Funded Ratios
above or below 80 Percent:
[See PDF for image]
This figure is a stacked bar graph depicting the following data:
Fiscal year: 1994;
Funded ratio 80 percent or more: approximately 60%;
Funded ratio less than 80 percent: approximately 40%.
Fiscal year: 1996;
Funded ratio 80 percent or more: approximately 68%;
Funded ratio less than 80 percent: approximately 32%.
Fiscal year: 2000;
Funded ratio 80 percent or more: approximately 95%;
Funded ratio less than 80 percent: approximately 5%.
Fiscal year: 2001;
Funded ratio 80 percent or more: approximately 93%;
Funded ratio less than 80 percent: approximately 7%.
Fiscal year: 2002;
Funded ratio 80 percent or more: approximately 88%;
Funded ratio less than 80 percent: approximately 12%.
Fiscal year: 2003;
Funded ratio 80 percent or more: approximately 82%;
Funded ratio less than 80 percent: approximately 18%.
Fiscal year: 2004;
Funded ratio 80 percent or more: approximately 80%;
Funded ratio less than 80 percent: approximately 20%.
Fiscal year: 2005;
Funded ratio 80 percent or more: approximately 68%;
Funded ratio less than 80 percent: approximately 32%.
Fiscal year: 2006;
Funded ratio 80 percent or more: approximately 62%;
Funded ratio less than 80 percent: approximately 38%.
Source: GAO analysis of PFS, PENDAT data.
[End of figure]
What GAO Recommends:
GAO is not making recommendations in this report. Experts on public
benefits funding provided technical clarifications, which were
incorporated as appropriate.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.GAO-08-223]. For more information, contact
Barbara Bovbjerg at (202) 512-7215 or bovbjergb@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Key Measures of the Funded Status of Retiree Benefits Are
Contributions, Funded Ratios, and Unfunded Liabilities of Individual
Plans over Time:
Most Public Pensions Have Assets to Pay Benefits over Several Decades,
Though Contributions Vary, While Unfunded Liabilities for Retiree
Health Are Significant:
Concluding Observations:
Agency Comments:
Appendix I: Objectives, Scope, and Methodology:
Related GAO Products:
Tables:
Table 1: Effective Dates for GASB Statements 43 and 45, Requiring
Public Employers to Estimate Health Care Liabilities:
Table 2: Normal Cost Calculations for Three Most Commonly Used
Actuarial Cost Methods:
Figures:
Figure 1: Relationship among the Key Measures of the Funded Status:
Figure 2: Division of the Current Value of Future Benefits among Time
Periods:
Figure 3: Percentage of State and Local Government Pension Plans with
Funded Ratios above or below 80 Percent, by Fiscal Year:
Figure 4: Percentage of State and Local Government Pension Plans for
which Governments Contributed More or Less Than 100 Percent of the ARC,
by Fiscal Year:
Abbreviations:
ARC: annual required contribution:
AAL: actuarial accrued liability:
ERISA: Employee Retirement Income Security Act:
GASB: Governmental Accounting Standards Board:
NASRA: National Association of State Retirement Administrators:
PFS: Public Fund Survey:
PBGC: Pension Benefit Guaranty Corporation:
PPCC: Public Pension Coordinating Council:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
January 29, 2008:
The Honorable Max Baucus:
Chairman:
The Honorable Charles E. Grassley:
Ranking Member:
Committee on Finance:
United States Senate:
Nearly 20 million employees and 7 million retirees and dependents of
state and local governments--including school teachers, police,
firefighters, and other public servants--are promised pensions, and
many are promised retiree health benefits. Many of these benefits are
guaranteed by state law or contract and represent actuarial accrued
liabilities[Footnote 1] for state and local governments and ultimately
the taxpayer. Typically, pension benefits are paid from a fund made up
of assets from employers' and employees' annual contributions and the
investment earnings from those contributions. Such a fund has an
unfunded liability when the actuarial value of assets is less than
actuarial accrued liabilities. Accounting standards have called for
state and local governments to report their unfunded pension
liabilities since 1986. But accounting standards have only recently
been established that call for reporting the size of unfunded retiree
health liabilities. While few state and local governments have as yet
officially reported these unfunded liabilities, some studies have
estimated that they may exceed $1 trillion dollars nationwide in
present value terms. Such estimates raise concerns about the fiscal
challenges that state and local governments will face in the coming
decades. As discussion of the unfunded liabilities of state and local
governments has increased, questions have been raised by some about how
to understand these amounts.
State and local retiree benefits are not subject, for the most part, to
the federal funding requirements that apply to pensions sponsored by
private employers. Nevertheless, the federal government has an interest
in assuring that all Americans have a secure retirement, as reflected
in the federal tax deferral for contributions to both public and
private pension plans. Given the concerns about unfunded liabilities
for state and local retiree benefits, we are reporting on: 1) the key
measures of the funded status of retiree benefits and 2) the current
funded status of retiree benefits.
To address these objectives, we reviewed literature and interviewed a
range of experts and stakeholders, including national associations of
state and local officials, labor unions, bond raters, and actuarial and
accounting professionals, among others. To describe the funded status
of state and local pension plans, we analyzed self-reported data from
the Public Fund Survey (PFS) as well as surveys by the Public Pension
Coordinating Council (PPCC).[Footnote 2] This report represents one of
two recent reports on state and local government retiree benefits. The
other report, State and Local Government Retiree Benefits: Current
Status of Benefit Structures, Protections, and Fiscal Outlook for
Funding Future Costs (GAO-07-1156), provides a descriptive overview of
such benefits.
We conducted our work in Washington, D.C.; New York; and Connecticut
from July 2006 to January 2008 in accordance with generally accepted
government auditing standards.
Results in Brief:
Three key measures help to understand different aspects of the funded
status of state and local government retiree benefits. First,
governments' annual contributions indicate the extent to which they are
keeping up with the value of benefits as they are accumulating. Second,
the funded ratio indicates the percentage of a plan's liabilities
covered by its assets. Third, unfunded liabilities indicate the excess,
if any, of liabilities over assets in dollars. Low funded ratios
correspond to high unfunded liabilities and require larger future
contributions to pay benefits, which may create future budget problems
and means future generations will bear more of the cost. Governments
have been reporting these funded status measures for pensions for
years. However, new accounting rules will also call on governments to
report the funded status of retiree health benefits in a similar
manner, even though many have not made any contributions to build
assets to cover liabilities. These funded status measures should be
reviewed using several years of data because in some years fiscal
pressures may encourage governments to choose other budget priorities.
Also, the value of assets can fluctuate from year to year with changes
in investment returns, so examining a single year of funding data can
be misleading. Because governments use a variety of methods and
actuarial assumptions to calculate the funded status, different plans
cannot be easily compared.
Currently, most state and local government pension plans have enough
invested resources set aside to pay for the benefits they are scheduled
to pay over the next several decades, but governments that offer
retiree health benefits generally have large unfunded liabilities. Many
experts consider a funded ratio of about 80 percent or better to be
sound for state and local government pensions. According to the self-
reported PFS data, 58 percent of 65 large public pension plans were
funded to that level in 2006, a decrease since 2000 when about 90
percent of plans were so funded. While most plans' funding may be
sound, a few plans have persistently reported low funded ratios. Low
funded ratios will eventually require the government employer to
improve funding, for example, by reducing benefits or by increasing
contributions. Increasing contributions may require revenue increases
or reductions in non-benefit spending. However, even for many plans
with lower funded ratios, benefits are generally not at risk in the
near term because current assets and new contributions may be
sufficient to pay benefits for several years. Still, many governments
have often contributed less than the amount needed to improve or
maintain funded ratios. Low contributions raise concerns about the
future funded status, and may shift costs to future generations. For
retiree health benefits, various studies estimate that the total
unfunded liability for state and local governments lies between $600
billion and $1.6 trillion although the estimates are based on samples
of governments that are not necessarily representative. The unfunded
liabilities are large because state and local governments typically
have not set aside any funds for future retiree health benefits in the
way they have for pensions. Instead, their practice has been to pay for
the retiree health benefits due in a given year from the revenues for
that year, like many private employers. This financing approach can
leave little flexibility for governments, and therefore may stress
future budgets. As a result, as health care costs increase, governments
may face even greater pressure to reduce benefits or increase revenues.
However, our analysis shows that the annual amount paid for retiree
health benefits is currently low compared to pensions, but growth of
health costs will be faster and less predictable.
The Internal Revenue Service and experts in the field provided
technical comments, which we incorporated as appropriate.
Background:
State and local governments will likely face daunting fiscal challenges
in the next few years, driven in large part by the growth in health-
related costs.[Footnote 3] Medicaid and health insurance for state and
local employees and retirees make up a large share of such costs. In
contrast, our analysis shows that state and local governments on
average would need to increase pension contribution rates to 9.3
percent of salaries--less than .5 percent more than the 9.0 percent
contribution rate in 2006 to achieve healthy funding on an ongoing
basis.
With few exceptions, defined benefit pension plans still provide the
primary pension benefit for most state and local workers. About
90 percent of full-time state and local employees participated in
defined benefit pension plans as of 1998.[Footnote 4] A defined benefit
plan determines benefit amounts by a formula that is generally based on
such factors as years of employment, age at retirement, and salary
level.[Footnote 5] A few states offer defined contribution or other
types of plans as the primary retirement instrument.[Footnote 6] In
fiscal year 2006, state and local government pension systems covered
18.4 million members and made periodic payments to 7.3 million
beneficiaries, paying out $151.7 billion in benefits.
Many state and local governments also offer retirees health care
benefits--in addition to Medicare benefits provided by the federal
government--the costs of which have been growing rapidly. One study
estimated that state and local governments paid $20.7 billion in fiscal
year 2004 for retiree health benefits. For retirees who are under age
65 (that is, not yet Medicare-eligible), many state and local employers
provide access to group health coverage with varying levels of employer
contributions. As of 2006, 14 states did not contribute to the premium
for this coverage, while 14 states picked up the entire cost, and the
remainder fell somewhere in between. For virtually all state and local
retirees age 65 or older, Medicare provides the primary coverage. Most
state and local government employers provide supplemental coverage for
Medicare-eligible retirees that covers prescription drugs.[Footnote 7]
Financing of State and Local Retiree Benefits:
Both government employers and employees generally make contributions to
fund state and local pension benefits. States follow statutes
specifying contribution amounts or determine the contribution amount
each legislative session. However many state and local governments are
statutorily required to make yearly contributions based either on
actuarial calculations or according to a statutorily specified amount.
For plans in which employees are covered by Social Security, the median
contribution rate in fiscal year 2006 was 8.5 percent of payroll for
employers and 5 percent of pay for employees, in addition to 6.2
percent of payroll from both employers and employees to Social
Security. For plans in which employees are not covered by Social
Security, the median contribution rate was 11.5 percent of payroll for
employers and 8 percent of pay for employees.
Actuaries estimate the amount that will be needed to pay future
benefits. The benefits that are attributable to past service are called
the "actuarial accrued liabilities." (In this report, the actuarial
accrued liabilities are referred to as "liabilities.") Actuaries
calculate liabilities based on an actuarial cost method and a number of
assumptions including discount rates and worker and retiree mortality.
Actuaries also estimate the "actuarial value of assets" that fund a
plan (in this report, the actuarial value of assets is referred to as
"assets"). The excess of actuarial accrued liabilities over the
actuarial value of assets is referred to as the "unfunded actuarial
accrued liability" or "unfunded liability." Under accounting standards,
such information is disclosed in financial statements. In contrast, the
liability that is recognized on the balance sheet is the cumulative
excess of annual benefit costs over contributions to the plan. Certain
amounts included in the actuarial accrued liability are not yet
recognized as annual benefit costs under accounting standards, as they
are amortized over several years.
In a typical defined benefit pension plan, employer and employee
contributions are made to a specific fund from which benefits will be
paid. The yearly contributions from employers and employees are
invested in the stock market, bonds, and other investments. Unlike most
pension plans, retiree health benefits have generally been financed on
a pay-as-you-go basis. Pay-as-you-go financing means that state and
local governments have not set aside funds in a trust reserved for
future retiree health costs. Instead, governments pay for each year's
retiree health benefits from the current year's budget.
Oversight of State and Local Retiree Benefits:
The federal government has an interest in the funded status of state
and local government retiree pensions and health care, even though it
has not imposed the same funding and reporting requirements as it has
on private sector pension plans. State and local government pension
plans are not covered by most of the substantive requirements, or the
insurance program operated by the Pension Benefit Guaranty Corporation
(PBGC), under the Employee Retirement Income Security Act of 1974
(ERISA), which apply to most private employer benefit plans. Federal
law generally does not require state and local governments to prefund
or report on the funded status of pension plans or health care
benefits.[Footnote 8] However, in order to receive preferential tax
treatment, state and local pensions must comply with requirements of
the Internal Revenue Code. In addition, the retirement income security
of all Americans is an ongoing concern of the federal government.
All states have legal protections for their pensions. The majority of
states have constitutional provisions prescribing how pension trusts
are to be funded, protected, managed, or governed. The remaining states
have pension protections in their statutes or recognize legal
protections under common law. Legal protections usually apply to
benefits for existing workers or benefits that have already accrued;
thus, state and local governments generally can change the benefits for
new hires.[Footnote 9] In contrast to pensions, retiree health benefits
generally do not have the same constitutional or statutory protections.
Instead, to the extent retiree health benefits are legally protected,
it is generally because they have been collectively bargained and are
subject to current labor contracts.
Since the 1980s, the Governmental Accounting Standards Board (GASB) has
maintained standards for accounting and financial reporting for state
and local governments. GASB operates independently and has no authority
to enforce the use of its standards. Still, many state laws require
local governments to follow GASB standards, and bond raters do consider
whether GASB standards are followed. Also, to receive a "clean" audit
opinion under generally accepted accounting principles, state and local
governments are required to follow GASB standards. These standards
require reporting financial information on pensions, such as
contributions and the ratio of assets to liabilities. In contrast to
pensions, the financial status of retiree health care benefits has
generally not been reported or even estimated actuarially until
recently. However, new GASB standards (Statements 43 and 45) call for
employers to quantify and report on the size of retiree health care
benefit liabilities. The new health care reporting standards are being
phased in over time to give more time to smaller state and local
government sponsors to generate estimates. Table 1 shows the respective
GASB 43 and 45 effective dates, as well as to what type of entity each
statement applies.
Table 1: Effective Dates for GASB Statements 43 and 45, Requiring
Public Employers to Estimate Health Care Liabilities:
GASB 43:
Applies to: Plans administered as trusts and multiple-employer plans
that are not administered as trusts;
Total annual revenues as of 1999: $100,000,000 or more: Applies for
periods beginning after 12/15/05;
Total annual revenues as of 1999: $10,000,000 - $99,999,999: Applies
for periods beginning after 12/15/06;
Total annual revenues as of 1999: Less than $10,000,000: Applies for
periods beginning after 12/15/07.
GASB 45:
Applies to: All employers that provide retiree health benefits.
Total annual revenues as of 1999: $100,000,000 or more: Applies for
periods beginning after 12/15/05;
Total annual revenues as of 1999: $10,000,000 - $99,999,999: Applies
for periods beginning after 12/15/06;
Total annual revenues as of 1999: Less than $10,000,000: Applies for
periods beginning after 12/15/07.
Source: GASB.
[End of table]
Key Measures of the Funded Status of Retiree Benefits Are
Contributions, Funded Ratios, and Unfunded Liabilities of Individual
Plans over Time:
Understanding the financial health of pension plans can be confusing.
To help clarify, we found that three measures are key to understanding
pension plans' funded status. GASB standards require reporting all
three of these measures. First, one can look at yearly contributions
governments are making to their plans. Actuaries calculate yearly
contribution amounts needed to maintain or improve the funded status of
plans over time. Comparing this amount to the amount governments
actually contribute indicates how well governments are keeping up with
yearly funding needs. Two other measures, funded ratios and unfunded
liabilities, both suggest the extent to which current assets can cover
accrued benefits. These three measures should be viewed together and
over time to get a complete picture of the funded status. The funded
status measures of different plans cannot be compared to one another
easily because different governments use different actuarial funding
methods and assumptions to estimate them.
Three Measures, Viewed in Relation to One Another over Time, Describe
Funded Status:
Some officials we interviewed expressed confusion about how to
understand the funded status of public pension plans. State and local
governments report a significant amount of information on funding,
required by GASB standards. The media often report various measures of
the funded status without explaining the meaning of the terms or
without enough context. In addition, governments have been reporting
these funded status measures for pensions for years. However, the new
accounting rules will also call on governments to report the funded
status of retiree health benefits in a similar manner, even though many
have not made any contributions to build assets to cover liabilities.
We identified three key measures to help explain plans' funded status:
contributions, funded ratios, and unfunded liabilities. According to
experts we interviewed, any single measure at a point in time may give
a dimension of a plan's funded status, but it does not give a complete
picture. Instead, the measures should be reviewed collectively over
time to understand how the funded status is improving or worsening. For
example, a strong funded status means that, over time, the amount of
assets, along with future scheduled contributions, comes close to
matching a plan's liabilities.
Comparing governments' actual contributions to the "annual required
contribution" (ARC) helps in evaluating the funded status of each plan.
Each year, plan actuaries calculate a contribution amount that, if paid
in full, would normally maintain or improve the funded status.[Footnote
10] This amount is referred to as the ARC, although the use of the word
"required" can be misleading because governments can choose to pay more
or less than this amount.[Footnote 11] If the actuarial assumptions are
consistent with the plans' future experience, paying the full ARC each
year provides reasonable assurance that sufficient money is being set
aside to cover currently accruing benefits as well as a portion of any
unfunded accrued benefits left over from previous years, instead of
leaving those costs for the future. In other words, when a government
consistently pays the ARC, the benefits accrued by employees are paid
for by the taxpayers who receive the employees' services. When the ARC
is not paid in full each year, future generations must make up for the
costs of benefits that accrued to employees in the past. In addition,
the ARC can be compared to the government's yearly budget to understand
the financial burden of the benefits, according to officials. This
comparison indicates how affordable the plan is to the government in a
given year. A high ARC relative to a government's budget may indicate
that the costs of benefits are relatively high or that payments have
been deferred from previous years.
The funded ratio is the ratio of assets to liabilities. Liabilities are
the amount governments owe in benefits to current employees who have
already accrued benefits they will collect in the future. The funded
ratio indicates the extent to which a plan has enough funds set aside
to pay accrued benefits. If a plan has a funded ratio of 80 percent,
the plan has enough assets to pay for 80 percent of all accrued
benefits. A rising funded ratio over time indicates that the government
is accumulating the assets needed to make future payments for benefits
accrued to date. A low or declining funded ratio over time may raise
concerns that the government will not have the assets set aside to pay
for benefits.
While the funded ratio equals the ratio of assets to liabilities,
unfunded liabilities equal the difference between liabilities and
assets in dollars. Thus, unfunded liabilities indicate the amount of
benefits accrued for which no money is set aside. Assets may fall short
of liabilities, for example, when governments do not contribute the
full ARC, when they increase benefits retroactively, or when returns on
investments are lower than assumed. Additionally, because all these
financial calculations involve estimates of future payments, they are
based on a number of assumptions about the future. Unfunded liabilities
can grow if actuaries' assumptions do not hold true. For example, if
beneficiaries live longer than anticipated, they will receive more
benefits than predicted, even if the government has been paying the ARC
consistently. Unfunded liabilities will eventually require the
government employer to increase revenue, reduce benefits or other
government spending, or do some combination of these. Revenue increases
could include higher taxes, returns on investments, or employee
contributions. Nevertheless, we found that unfunded liabilities do not
necessarily imply that pension benefits are at risk in the near term.
Current funds and new contributions may be sufficient to pay benefits
for several years, even when funded ratios are relatively low.
As described in figure 1, unfunded liabilities are calculated as
intermediate steps in the process of calculating the ARC. After
calculating the unfunded liabilities, actuaries usually determine an
amount to fund the unfunded liabilities over several years or
"amortize" the cost of the liability. That amortized portion is added
to the cost of benefits that employees accrued in the current year to
determine the ARC. If a government pays the ARC, then a portion of the
unfunded liabilities is paid off each year. When no more unfunded
liabilities exist, the funded ratio is 100 percent, and the plan has
"fully funded" all the benefits that its current employees have accrued
under the plan's actuarial cost method. However, a fully funded plan
still requires yearly contributions to maintain full funding because as
employees perform additional service, they accrue additional benefits.
Figure 1: Figure 1. Relationship among the Key Measures of the Funded
Status:
[See PDF for image]
This figure is an illustration of the relationship among the key
measures of the Funded Status. The illustration depicts the following
information:
Funded ratio:
Assets divided by liabilities (which include unfunded liabilities);
Portion of unfunded liabilities to be paid off this year:
ARC: cost of benefits accrued this year;
Actual contribution: May be greater or less than ARC.
Assets: = sum of past contributions from the state and local government
plan sponsors, employees, and investment earnings that have not been
paid out in benefits or administrative expenses.
Liabilities = current cost of all future benefits that have been
accrued to date.
Source: GAO analysis; images partially by Art Explosion.
[End of figure]
The funded status measures should be reviewed over time because several
factors can affect them. In particular, the money set aside is invested
and returns can fluctuate. If a plan's invested assets grow at a rate
significantly above or below the rate assumed for funding purposes in a
given year, it can change the funded status measures, regardless of the
government's contributions. Granting retroactive benefits also
increases liabilities and increases unfunded liabilities, even if a
government has been contributing the full ARC each year. Funded ratios
and unfunded liabilities also can reflect changes in assumptions about
member characteristics. For example, as plan members are projected to
live in retirement longer, the estimated amount expected to be paid for
future benefits rises.
Comparing the Funded Status of Different Plans Is Difficult:
Under GASB reporting standards, the funded status of different pension
plans cannot be compared easily because governments use different
actuarial approaches such as different actuarial cost methods,
assumptions, amortization periods, and "smoothing" mechanisms.
Actuarial Cost Methods:
Most public pension plans use one of three "actuarial cost methods,"
out of the six GASB approves. Actuarial cost methods differ in several
ways. First, each uses a different approach to calculate the "normal
cost," the portion of future benefits that the cost method allocates to
a specific year, resulting in different funding patterns for each, as
described in Table 2.
Table 2: Normal Cost Calculations for Three Most Commonly Used
Actuarial Cost Methods:
Actuarial cost Method: Projected unit credit;
Description: Projected benefits of each employee covered by the plan
are allocated by a consistent formula to valuation years;
How the method calculates the normal cost for the current year: Equal
to the current value of the future benefit that each employee earned
this year, using the employee's projected salary at retirement as a
base.
Actuarial cost Method: Entry age normal;
Description: The current value of future benefits of each employee is
allocated on a level basis over the earnings or service of the employee
between entry age and assumed exit age;
How the method calculates the normal cost for the current year: Equal
to the level percentage of payroll that would exactly fund each
employee's prospective benefits if contributed from the member's date
of eligibility until retirement.
Actuarial cost Method: Aggregate;
Description: The excess of the value of future benefits of all
employees over the current value of assets is allocated on a level
basis over the earnings or service of the group between the valuation
date and assumed exit. This allocation is performed for the group as a
whole, not as a sum of individual allocations;
How the method calculates the normal cost for the current year: The
percentage of payroll equal to the current value of future benefits
minus assets, divided by the current value of future salaries.
Sources: Actuarial Standards Board, Government Accountants Journal,
Organization for Economic Cooperation and Development, American Academy
of Actuaries.
[End of table]
The Aggregate Cost Method:
Some news reports have expressed uncertainty about the use of the
aggregate actuarial cost method, but experts indicated that the
aggregate method is as sound as the other methods. Experts explained
that under the aggregate method, unfunded liabilities are allocated as
future normal costs instead of being amortized and added to the normal
cost. As a result, no unfunded liabilities are reported, and the funded
ratio is often reported as 100 percent and year-to-year payments may be
more volatile. Relatively few plans actually employ the aggregate
method. For those plans, GASB recently began to require governments to
report the funded ratio using the entry age normal method.
Actuarial cost methods are used to allocate the current value of future
benefits into amounts attributable to the past, to the current year,
and to future years, as shown in figure 2. The cost of future benefits
that are attributable to past years under the actuarial cost method is
called the actuarial accrued liability (AAL), while the cost of
benefits accrued under the cost method in the current year is known as
the normal cost.
Figure 2: Division of the Current Value of Future Benefits among Time
Periods:
[See PDF for image]
This figure is a chart that depicts the following information:
Current value of future benefits:
Can be divided into:
* Actuarial accrued liability (AAL), benefits accrued in past years;
* Normal cost, benefits accrued in the current year;
* Future normal costs, benefits that will accrue in future years.
Source: Paul Angelo, Fellow of the Society of Actuaries, and GAO.
[End of figure]
The funded status of plans using different cost methods differs because
each has a different approach to dividing up the value of future
benefits. Different cost methods are designed for plans to accrue
liabilities at different rates, so the normal cost and the AAL vary
according to the cost method. For example, under some cost methods,
governments accrue more liabilities in the early part of employees'
career rather than later. As a result, two identical plans, using
identical actuarial assumptions but different cost methods, would
report a different funded status.[Footnote 12]
Some Call for Assuming Risk-Free Investment Returns:
Some in the pension community have been advocating an alternative
approach to measuring the funded status of public plans. Proponents of
this approach point to certain implications of the field of "financial
economics" that suggest that using the expected rate of return to
project future fund earnings does not adequately take into account the
risk inherent in some investments. They believe it is preferable, for
disclosure purposes, that a plan's assets and liabilities be "marked to
market." In particular, plan liabilities should be measured,
independent of the actuarial cost method used for funding, as the cost
of closing out the plan's accrued benefit obligations based on service
to date. This implies using the cost of annuities or discounting the
expected cash flows using a risk-free rate of return and would likely
result in much less favorable funded status estimates. Further, they
believe that using a "smoothed" value of assets rather than the market
value of assets obscures the plan's risk profile and may have
operational consequences as well.
Most governments do not use risk-free return assumptions to calculate
funded status. Most public plan actuaries believe that using this
approach is inappropriate because their plans do invest in diversified
portfolios with higher rates of returns than risk-free rates. Those
higher returns are reasonable to expect, they feel, based on past
experience and will decrease the contributions that would be required
if assumed returns were lower. Their current practice, they argue,
produces estimates of contributions that best reflect what will
actually be required on average over the long term. Using a risk-free
return assumption would result in higher current contribution rates,
requiring current taxpayers to pay more for the cost of future
benefits.
Assumptions:
In addition to the cost methods, differences in assumptions used to
calculate the funded status can result in significant differences among
plans that make comparisons difficult. One key assumption is the rate
at which governments assume their invested assets will grow. If
governments assume a high growth rate, their calculations will indicate
that they do not have to pay as much today, because the assets set
aside will grow more rapidly. In 2006, 70 percent of state and local
government pension plans assumed a return of 8.0 to 8.5 percent, while
30 percent assumed a lower rate of return (7 percent at the lowest). If
a plan's assets fail to grow at the assumed rate of return, then the
shortfall becomes part of the unfunded liabilities. However, in other
years, assets may earn more than the assumed rate of return, reducing
unfunded liabilities.
Amortization Periods for Unfunded Liabilities:
In addition to actuarial cost methods and assumptions, differences in
amortization periods make it difficult to compare the funded status of
different plans. Governments amortize unfunded liabilities to reduce
the volatility of contributions from year to year. Governments can
choose shorter or longer periods over which to amortize unfunded
liabilities. GASB standards allow governments to amortize unfunded
liabilities over a period of up to 30 years.[Footnote 13] State and
local governments can amortize their benefits because there is little
chance that they will cease to exist.
Smoothing Periods:
Finally, actuaries for many plans calculate the value of current assets
based on an average value of past years. As a result, if the value of
assets fluctuates significantly from year to year, the "smoothed" value
of assets changes less dramatically. GASB does not limit the number of
years governments may use to smooth the value of assets, but in 2006,
most governments averaged the value of current assets with those of the
last zero to 5 years. Comparing the funded status of plans that use
different smoothing periods can be confusing because the value of the
different plans' assets reflects a different number of years. Given
fluctuations in the stock market from year to year, the reported value
of assets for plans that use different numbers of years for smoothing
calculations could reflect significantly different market returns.
Most Public Pensions Have Assets to Pay Benefits over Several Decades,
Though Contributions Vary, While Unfunded Liabilities for Retiree
Health Are Significant:
More than half of public pension plans reported that they have put
enough assets aside in advance to pay for benefits over the next
several decades, while governments providing retiree health benefits
generally have significant unfunded liabilities. The percentage of
pension plans with funded ratios below 80 percent, a level viewed by
many experts as sound, has increased in recent years, and a few plans
are persistently underfunded. Although members of these plans may not
be at risk of losing benefits in the near term, the unfunded
liabilities will have to be made up in the future. In addition, a
number of governments reported not contributing enough to reduce
unfunded liabilities, which can shift costs to future generations. For
state and local governments' retiree health benefits, studies have
estimated unfunded liabilities nationwide to be between $600 million
and $1.6 trillion, although the amounts for individual governments vary
widely. Even though annual costs for retiree health benefits are
currently low compared to pensions, continuing to pay for current
benefits with current revenues can put stress on government budgets
because health care costs are increasing rapidly.
Most Public Pension Plans Have Enough Funds to Pay for Benefits over
the Long-Term:
Most public pension plans report having sufficient assets to pay for
retiree benefits over the next several decades. Many experts and
officials to whom we spoke consider a funded ratio of 80 percent to be
sufficient for public plans for a couple of reasons.[Footnote 14]
First, it is unlikely that public entities will go bankrupt as can
happen with private sector employers, and state and local governments
can spread the costs of unfunded liabilities over up to 30 years under
current GASB standards. In addition, several commented that it can be
politically unwise for a plan to be overfunded; that is, to have a
funded ratio over 100 percent. The contributions made to funds with
"excess" assets can become a target for lawmakers with other priorities
or for those wishing to increase retiree benefits.
More than half of state and local governments' plans reviewed by the
Public Fund Survey (PFS) had a funded ratio of 80 percent or better in
fiscal year 2006, but the percentage of plans with a funded ratio of 80
percent or better has decreased since 2000, as shown in figure
3.[Footnote 15] Our analysis of the PFS data on 65 self-reported state
and local government pension plans showed that 38 (58 percent) had a
funded ratio of 80 percent or more, while 27 had a funded ratio of less
than 80 percent. In the early 2000s, according to one study, the funded
ratio of 114 state and local government pension plans together reached
about 100 percent; it has since declined.[Footnote 16] In fiscal year
2006, the aggregate funded ratio was about 86 percent. Some officials
attribute the decline in funded ratios since the late 1990s to the
decline of the stock market, which reduced the value of assets. This
sharp decline would likely affect funded ratios for several years
because most plans use smoothing techniques to average out the value of
assets over several years. Our analysis of several factors affecting
the funded ratio showed that changes in investment returns had the most
significant impact on the funded ratio between 1988 and 2005, followed
by changes in liabilities.[Footnote 17]
Figure 3: Percentage of State and Local Government Pension Plans with
Funded Ratios above or below 80 Percent, by Fiscal Year:
[See PDF for image]
Fiscal year: 1994;
Funded ratio 80 percent or more: approximately 60%;
Funded ratio less than 80 percent: approximately 40%.
Fiscal year: 1996;
Funded ratio 80 percent or more: approximately 68%;
Funded ratio less than 80 percent: approximately 32%.
Fiscal year: 2000;
Funded ratio 80 percent or more: approximately 95%;
Funded ratio less than 80 percent: approximately 5%.
Fiscal year: 2001;
Funded ratio 80 percent or more: approximately 93%;
Funded ratio less than 80 percent: approximately 7%.
Fiscal year: 2002;
Funded ratio 80 percent or more: approximately 88%;
Funded ratio less than 80 percent: approximately 12%.
Fiscal year: 2003;
Funded ratio 80 percent or more: approximately 82%;
Funded ratio less than 80 percent: approximately 18%.
Fiscal year: 2004;
Funded ratio 80 percent or more: approximately 80%;
Funded ratio less than 80 percent: approximately 20%.
Fiscal year: 2005;
Funded ratio 80 percent or more: approximately 68%;
Funded ratio less than 80 percent: approximately 32%.
Fiscal year: 2006;
Funded ratio 80 percent or more: approximately 62%;
Funded ratio less than 80 percent: approximately 38%.
Source: GAO analysis of PFS, PENDAT data.
[End of figure]
Although most plans report being soundly funded in 2006, a few have
been persistently underfunded, and some plans have seen funded ratio
declines in recent years.[Footnote 18] We found that several plans in
our data set had funded ratios below 80 percent in each of the years
for which data is available. Of 70 plans in our data set, 6 had funded
ratios below 80 percent for 9 years between 1994 and 2006. Two plans
had funded ratios below 50 percent for the same time period. In
addition, of the 27 plans that had funded ratios below 80 percent in
2006, 15 had lower funded ratios in 2006 than in 1994. The sponsors of
these plans may be at risk in the future of increased budget pressures.
By themselves, lower funded ratios and unfunded liabilities do not
necessarily indicate that benefits for current plan members are at
risk, according to experts we interviewed. Unfunded liabilities are
generally not paid off in a single year, so it can be misleading to
review total unfunded liabilities without knowing the length of the
period over which the government plans to pay them off. Large unfunded
liabilities may represent a fiscal challenge, particularly if the
period to pay them off is short. But all unfunded liabilities shift the
responsibility for paying for benefits accrued in past years to the
future.
Some Pension Sponsors Do Not Contribute Enough to Improve Funding
Status:
A number of governments reported not contributing enough to keep up
with yearly costs. Governments need to contribute the full ARC yearly
to maintain the funded ratio of a fully funded plan or improve the
funded ratio of a plan with unfunded liabilities. In fiscal year 2006,
the sponsors of 46 percent of the 70 plans in our data set contributed
less than 100 percent of the ARC, as shown in figure 4, including 39
percent that contributed less than 90 percent of the ARC. In fact, the
percentage of governments contributing less than the full ARC has risen
in recent years. This continues a trend in recent years of about half
of governments making full contributions.
Figure 4: Percentage of State and Local Government Pension Plans for
which Governments Contributed More or Less Than 100 Percent of the ARC,
by Fiscal Year:
[See PDF for image]
This figure is a stacked bar graph depicting the following data:
Fiscal year: 1994;
Percentage of plans, 100 percent or more of the ARC: approximately 14%;
Percentage of plans, Less than 100 percent of the ARC: approximately
86%.
Fiscal year: 1996;
Percentage of plans, 100 percent or more of the ARC: approximately 82%;
Percentage of plans, Less than 100 percent of the ARC: approximately
18%.
Fiscal year: 2000;
Percentage of plans, 100 percent or more of the ARC: approximately 76%;
Percentage of plans, Less than 100 percent of the ARC: approximately
24%.
Fiscal year: 2001;
Percentage of plans, 100 percent or more of the ARC: approximately 80%;
Percentage of plans, Less than 100 percent of the ARC: approximately
20%.
Fiscal year: 2002;
Percentage of plans, 100 percent or more of the ARC: approximately 64%;
Percentage of plans, Less than 100 percent of the ARC: approximately
36%.
Fiscal year: 2003;
Percentage of plans, 100 percent or more of the ARC: approximately 60%;
Percentage of plans, Less than 100 percent of the ARC: approximately
40%.
Fiscal year: 2004;
Percentage of plans, 100 percent or more of the ARC: approximately 55%;
Percentage of plans, Less than 100 percent of the ARC: approximately
45%.
Fiscal year: 2005%;
Percentage of plans, 100 percent or more of the ARC: approximately 55%;
Percentage of plans, Less than 100 percent of the ARC: approximately
45%.
Fiscal year: 2006;
Percentage of plans, 100 percent or more of the ARC: 58%;
Percentage of plans, Less than 100 percent of the ARC: 42%.
Source: GAO analysis of PFS, PENDAT data.
[End of figure]
In particular, some of the governments that did not contribute the full
ARC in multiple years were sponsors of plans with lower funded ratios.
In 2006, almost two-thirds of plans with funded ratios below 80 percent
in 2006 did not contribute the full ARC in multiple years. Of the 32
plans that in 2006 had funded ratios below 80 percent, 20 did not
contribute the full ARC in more than half of the 9 years for which data
is available. In addition, 17 of these governments did not contribute
more than 90 percent of the full ARC in more than half the years.
State and local government pension representatives told us that
governments may not contribute the full ARC each year for a number of
reasons. First, when state and local governments are under fiscal
pressure, they may have to make difficult choices about paying for
competing interests. State and local governments will likely face
increasing fiscal challenges in the next several years as the cost of
health care continues to rise. In light of this stress, the ability of
some governments to continue to pay the ARC may be questioned. Second,
changes in the value of assets can affect governments' expectations
about how much they will have to contribute. Because a high proportion
of plan assets are invested in the stock market, the decline in the
early 2000s decreased funded ratios and increased the unfunded
liabilities of many plans. Such a marked decline in asset values was
not typical in the experience of public pension funds, according to one
expert. Reflecting the need to keep up with the increase in unfunded
liabilities, ARCs increased, challenging many governments to make full
contributions after they had grown accustomed to lower ARCs in the late
1990s. Moreover, some plans have contribution rates that are fixed by
constitution, statute, or practice and do not change in response to
changes in the ARC. Even when the contribution rate is not fixed, the
political process may take time to recognize and act on the need for
increased contributions. Nonetheless, many states have been increasing
their contribution rates in recent years, according to information
compiled by the National Conference of State Legislatures. Third, some
governments may not contribute the full ARC because they are not
committed to pre-funding their pension plans and instead have other
priorities, regardless of fiscal conditions.
When a government contributes less than the full ARC, the funded ratio
can decline and unfunded liabilities can rise, if all other assumptions
are met about the change in assets and liabilities.[Footnote 19]
Increased unfunded liabilities will require larger contributions in the
future to keep pace with the liabilities that accrue each year and to
make up for liabilities that accrued in the past. As a result, costs
are shifted from current to future generations.
Unfunded Retiree Health Liabilities Are Large for Many State and Local
Governments:
Our review of studies estimating the total retiree health benefits for
all state and local governments showed that liabilities are between
$600 billion and $1.6 trillion.[Footnote 20] The studies noted that,
like many private employers, few governments have set aside any assets
to pay for these obligations. The projected unfunded liabilities do not
have to be paid all at once, but can be paid over many years. Some
governments do not pay for any retiree health benefits and therefore do
not have any unfunded liabilities. Others may have large unfunded
liabilities. For example, California has estimated its unfunded retiree
health benefits liabilities at $70 billion, while the state of Utah
estimates $749 million.
Estimates of unfunded liabilities for retiree health benefits are
subject to change substantially because projecting future costs of
health care is difficult. Compared to the future payments for pension
benefits, payments for health care benefits are significantly more
unpredictable. Pension calculations generally use salaries as a base
for calculations and result in a predictable benefit amount per year.
But the cost of providing health care benefits varies with the changing
cost of health care as well as with each individual's usage. In
addition, state and local governments usually have the ability to
reduce or eliminate benefits.
Unfunded liabilities for retiree health benefits are high because
unlike pension plans, nearly all state and local government retiree
health benefits have been financed on a pay-as-you-go basis. In other
words, most governments have not set aside funds in a trust dedicated
for future retiree health benefit payments. As a result, governments do
not pay a yearly ARC, but rather pay for retiree health benefits as
they become due from annual funds. However, the new GASB accounting
standards will require state and local governments to report their
funding status on an accrual basis. In other words, for the first time,
most governments will begin to calculate and report their funding
status in a manner similar to the way they report pensions' funding
status, whether or not they are prefunded.
Officials told us that state and local governments have not prefunded
retiree health benefits for several reasons. First, for many
governments, retiree health benefits began as an extension of employee
health care benefits, which are usually paid for from general funds.
Governments did not view retiree health as a separate stream of
payments. Second, retiree health benefits were established at a time
when health care costs were more affordable, so paying for the benefits
as a yearly expense was less burdensome. Third, the inflation rate for
health care is less predictable than for pensions, so calculating the
current funding status is difficult. Fourth, given that specific
retiree health benefits are generally not guaranteed by law, employers
are freer to modify benefits; as a result, state and local governments
are reluctant to commit funds to an obligation that may be reduced or
eliminated in the future. Finally, changes in national health care
policy and health insurance markets can affect what benefits state and
local governments cover, so state and local governments may have
resisted locking in their commitment to pay for future retiree health
benefits by prefunding, and instead preferred to finance on a pay-as-
you-go basis.
Although the unfunded liabilities for retiree health benefits are
generally much higher than for pensions, their current annual payments
are considerably lower. According to our analysis presented in our
recent report on this topic,[Footnote 21] in 2006, the aggregate state
and local contribution rate for pensions was about 9 percent of
salaries, and the pay-as-you-go expense for retiree health benefits was
about 2 percent of salaries. However, if retiree health continues to be
financed on a pay-as-you-go basis, the pay-as-you-go amount is
estimated to more than double to 5 percent of salaries by 2050 to keep
up with the growth in health costs, adding to budgetary stress. Pay-as-
you-go financing also leaves less budgetary flexibility because state
and local governments must pay the full costs of each year's benefits.
In contrast, under pre-funding, benefits are paid from a fund that
already exists, so government contributions can be reduced when fiscal
pressures are great. As a result, governments may face even greater
pressure to reduce benefits or shift the costs of benefits to
beneficiaries, for example, by restricting eligibility, reducing
coverage, or increasing premiums. Still, pre-funding retiree health
benefits would require significantly higher contributions in the short
term than pay-as-you-go financing would require.
Concluding Observations:
Understanding the funded status of state and local government retiree
benefits requires examining, on a plan-by-plan basis, whether funding
levels are improving over time and whether governments are making the
contributions recommended by the plan's actuary each year. The variety
of actuarial funding methods and assumptions makes it difficult to
compare funded status across different pension plans. However, funded
status information is not intended to help compare plans, but rather to
determine contributions that will achieve full funding over time and to
assess a given plan's funded status over time.
The funded status of state and local government pensions overall is
reasonably sound, though recent deterioration underscores the
importance of keeping up with contributions, especially in light of
anticipated fiscal and economic challenges. Since the stock market
downturn in the early 2000s, the funded ratios of some governments have
declined. Governments can gradually recover from these losses. However,
the failure of some to consistently make the annual required
contributions undermines that progress and is cause for concern,
particularly as state and local governments will likely face increasing
fiscal pressure in the coming decades. While unfunded liabilities do
not generally put benefits at risk in the near-term, they do shift
costs and risks to the future.
In the case of retiree health benefits, pay-as-you-go financing has
been the norm up to the present day. The initial estimates of the
unfunded liabilities will be daunting. But that is a natural
consequence of pay-as-you-go financing. Just as the unfunded
liabilities did not accumulate overnight, it may be unrealistic to
expect them to be paid for overnight. Rather, state and local
governments need to find strategies for dealing with unfunded
liabilities, and such strategies will take time, will require difficult
choices, and could be affected by changes in national health policy.
Agency Comments:
We provided officials from the Internal Revenue Service, GASB staff,
and other external reviewers knowledgeable about the subject area a
copy of this report for their review. They provided us with technical
comments that we incorporated, where appropriate.
As agreed with your offices, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the report date. At that time, we will send copies of this report
to relevant congressional committees, the Acting Commissioner of
Internal Revenue, and other interested parties. Copies will also be
made available to others upon request. In addition, the report will be
available at no charge on the GAO Web site at [hypertext,
http://www.gao.gov]. Please contact me at (202) 512-7215, if you have
any questions about this report. Other major contributors include
Tamara Cross, Assistant Director; Ken Stockbridge; Anna Bonelli; Temeca
Simpson; Amy Abramowitz; Joseph Applebaum; Rick Krashevski; Jeremy
Schwartz; Walter Vance; Charles Willson; and Craig Winslow.
Signed by:
Barbara D. Bovbjerg:
Director, Education, Workforce, and Income Security Issues:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
The objectives of this report were to examine 1) the key measures of
the funded status of retiree benefits and 2) the current funded status
of state and local pension and retiree health benefits.
To describe the key measures of the funded status of retiree benefits,
we interviewed experts on state and local government pension and
retiree health benefits such as national organizations, bond rating
agencies, and representatives from one local government retiree benefit
system. We also spoke with experts on actuarial science such as the
Actuarial Standards Board, the American Academy of Actuaries, and
independent actuaries. We spoke to staff of the Governmental Accounting
Standards Board to understand accounting practices and principles. We
also reviewed actuarial literature and attended conferences. In
addition, we conducted the following analysis:
* To understand the impact of various economic factors on the funding
ratio of public pension plans, we developed a simple model of the
determinants of the funding ratio and conducted "counterfactuals"
holding rates of return on investments constant. To do this, we used
the following data sources:
* funding ratio data from the Public Fund Survey (PFS) for years 2001
to 2005 and the Survey of State and Local Pensions for years 1988 to
2000;
* market value of pension assets from the Federal Reserve's Flow of
Funds Accounts;
* contributions and benefits data from the Bureau of Economic
Analysis's National Income and Product Accounts database; and:
* data on returns on pension fund portfolios by analyzing market data.
* Our methodology and data sources for this analysis include some
limitations. First, annual data are not available in the Survey of
State and Local Pensions for 5 years during the period. For those
years, values were imputed by using the average growth between the two
closest values. In addition, the funding ratios are available on a
fiscal year basis and were subsequently adjusted to a calendar year
period. Second, assumptions may not be representative of all pension
plans, such as the assumptions based on smoothing functions and the
real expected returns on investments. Last, counterfactuals do not
include policy adjustments that may occur because of different rates of
return.
To describe the funded status of state and local governments' pensions,
in addition to a literature review, we analyzed pension funding data
provided by the National Association of State Retirement Administrators
(NASRA). The data come from two different databases. The first database
is the PFS and is sponsored by NASRA and the National Council on
Teacher Retirement (NCTR). Data from years 2001 to 2006 were available.
PFS data are gathered by reviewing publicly available financial
documents from the state and local government plans. The second
database is called the PENDAT database and was sponsored by the Public
Pension Coordinating Council. PENDAT data are available in fiscal years
1992, 1994, 1996, 1998, and 2000.[Footnote 22] PENDAT data were
collected via a survey sent to the administrators of a sample of plans
nationwide.
* The PFS and PENDAT databases do not include all of the same entries.
We matched individual entries from PENDAT to PFS, resulting in a sample
with between 63 and 71 plans that had data across each of the available
years from 1994 to 2006. In fiscal year 2005, these plans represented
58 percent of plan assets nationwide, and 72 percent of state and local
government pension plan members.
* We reviewed the PFS and PENDAT data and found them to be reliable for
our purposes. To do this, we reviewed all entries of key data points in
the PFS data using publicly available sources from the state and local
government plan sponsors and made adjustments to the data as needed.
The corrections made to the PFS data were not material. To review the
PENDAT database, we reviewed the methodology used to collect the data
and verified the data of 23 percent of entries using external sources.
The corrections were not found to be material.
* The information contained in the PFS and PENDAT databases have
limitations: 1) surveys, including PENDAT, are subject to several kinds
of error such as the failure to include all members of the population
in the sample, nonresponse error, and data processing error; 2) the
funding ratio and other funding indicators represent the financial
status for the fiscal year with the most recent actuarial valuation,
and thus do not all represent the same fiscal year's financial status;
3) the plans included in the analysis are not necessarily
representative of all state and local government pension plans
nationwide; and 4) data for every plan is not available in each year.
To obtain information on the funded status of retiree health benefits,
we interviewed experts on retiree health benefits funding from national
organizations, bond rating agencies, and one local government retiree
benefits system. We also reviewed studies conducted by various
organizations estimating the funded status. These organizations each
obtained information about retiree health benefits liabilities from a
number of different state and local governments and then extrapolated
these figures to generate a nationwide estimate of all state and local
governments. We reviewed the following studies:
* Credit Suisse, You Dropped a Bomb on Me, GASB, 2007. Limitations of
this study include: only states in the analysis, not local
jurisdictions, are included; assumes that those government entities for
which Credit Suisse was able to find estimates of future retiree health
benefit obligations were representative of governments overall in terms
of age distribution and funding levels; and does not consider the
variation in actuarial assumptions and methods between the different
plans.
* Cato Institute, Unfunded State and Local Health Costs: $1.4 Trillion,
2006. Limitations of this study include: includes states only in the
analysis, not local jurisdictions; assumes that those government
entities for which Cato was able to find estimates of future retiree
health benefit obligations were representative of governments overall
in terms of age distribution and funding levels; does not consider the
variation in actuarial assumptions and methods between the different
plans; it is not clear how many employees were covered by the sample
because there were so many localities; and figures on the percentage of
employees covered by health care plans in state and local government
jurisdictions may not be precise.
* OPEB for Public Entities: GASB 45 and Other Challenges, JP Morgan,
2005. Limitations of this study include: assumes that those government
entities for which they were able to find estimates of future retiree
health benefit obligations were representative of governments overall
in terms of age distribution and funding levels; and does not consider
the variation in assumptions and methods between the different plans.
We conducted our work in Washington, D.C.; New York; and Connecticut,
from July 2006 to January 2008 in accordance with generally accepted
government auditing standards.
[End of section]
Related GAO Products:
State and Local Government Retiree Benefits: Current Status of Benefit
Structures, Protections, and Fiscal Outlook for Funding Future Costs.
GAO-07-1156. Washington, D.C.: September 24, 2007.
State and Local Governments: Persistent Fiscal Challenges Will Likely
Emerge within the Next Decade. GAO-07-1080SP. Washington, D.C.: July
18, 2007.
Retiree Health Benefits: Majority of Sponsors Continued to Offer
Prescription Drug Coverage and Chose the Retiree Drug Subsidy. GAO-07-
572. Washington, D.C.: May 31, 2007.
Employer-Sponsored Health and Retirement Benefits: Efforts to Control
Employer Costs and the Implications for Workers. GAO-07-355.
Washington, D.C.: March 30, 2007.
State Pension Plans: Similarities and Differences Between Federal and
State Designs. GAO/GGD-99-45. Washington, D.C.: March 19, 1999.
Public Pensions: Section 457 Plans Pose Greater Risk than Other
Supplemental Plans. GAO/HEHS-96-38. Washington, D.C.: April 30, 1996.
Public Pensions: State and Local Government Contributions to
Underfunded Plans. GAO/HEHS-96-56. Washington, D.C.: March 14, 1996.
[End of section]
Footnotes:
[1] Actuarial accrued liabilities, referred to in this report as
"liabilities," are the portion of the present value of future benefits
that is attributable to employee services in past periods, under the
actuarial cost method utilized.
[2] The PFS is sponsored by the National Association of State
Retirement Administrators and the National Council on Teacher
Retirement. In 2005, the PFS data we used represented 58 percent of
total assets invested in public pension plans nationwide, and 72
percent of total members. PFS data covered years beginning with 2001.
PPCC data covered years 1994, 1996, and 2000.
[3] GAO, State and Local Governments: Persistent Fiscal Challenges Will
Likely Emerge within the Next Decade, GAO-07-1080SP (Washington, D.C.:
July 18, 2007).
[4] The last year for which the Bureau of Labor Statistics published
these data was 1998. U.S. Department of Labor, Bureau of Labor
Statistics, Employee Benefits in State and Local Governments, 1998
(Washington, D.C.: 2000).
[5] In contrast, for defined contribution plans, the key determinants
of the benefit amount are the employee's and employer's contribution
rates and the rate of return achieved on plan assets (made up of the
amounts contributed to an individual's account over time). Defined
contribution plans include 401(k)s.
[6] Two states (Alaska and Michigan) and the District of Columbia offer
defined contribution plans as their primary plan for general public
employees. Two states (Indiana and Oregon) offer primary plans with
both defined benefit and defined contribution components; and one state
(Nebraska) offers a cash balance defined benefit plan as its primary
plan.
[7] States also typically offer other retiree benefits such as vision,
dental, long-term care, and life insurance, but these are generally
funded entirely by retirees. For more information on the range and
types of benefits provided, see GAO, State and Local Government Retiree
Benefits: Current Status of Benefit Structures, Protections, and Fiscal
Outlook for Funding Future Costs, GAO-07-1156 (Washington, D.C.: Sept.
24, 2007).
[8] Similarly, ERISA generally does not include funding and reporting
requirements for private companies' health benefits.
[9] For more information on the protections for state and local retiree
benefits, see GAO, State and Local Government Retiree Benefits: Current
Status of Benefit Structures, Protections, and Fiscal Outlook for
Funding Future Costs, GAO-07-1156 (Washington, D.C.: Sept. 24, 2007).
[10] The ARC is made up of the amount of future benefits promised to
plan participants that accumulated in the current year, plus a portion
of any unfunded liabilities.
[11] Contributions from both sponsors and employees, combined with
investment earnings on plan assets, must cover both future benefit
payments and the administrative expenses associated with the plan.
[12] Even if a single method were required for financial reporting
purposes, government sponsors could still use a different method for
funding purposes, since financial reporting standards do not dictate
the fiscal policies used to fund the plans.
[13] Under GASB standards, sponsors can also re-amortize unfunded
liabilities each year, known as "open amortization." Under such an
approach, for example, each year sponsors can pay the annual cost for a
30-year amortization of that year's unfunded liabilities; the following
year, the sponsor can re-amortize the remaining unfunded liabilities
over an additional 30 years, and so on.
[14] The Pension Protection Act of 2006 provided that large private
sector pension plans will be considered at risk of defaulting on their
liabilities if they have less than 80 percent funded ratios under
standard actuarial assumptions and less than 70 percent funded ratios
under certain additional 'worst-case' actuarial assumptions. When
private sector plans default on their liabilities, the Pension Benefit
Guaranty Corporation becomes liable for benefits. These funding
standards will be phased in, becoming fully effective in 2011, and at-
risk plans are required to use stricter actuarial assumptions that will
result in them having to make larger plan contributions. Pub. L. No.
109-280, sec. 112(a), § 430(i), 120 Stat. 780, 839-42.
[15] In this section, we refer to our analysis of the Public Fund
Survey (PFS) and the PENDAT database. The PFS is sponsored by the
National Association of State Retirement Administrators and the
National Council on Teacher Retirement. These sources contain self-
reported data on state and local government pension plans in years
1994, 1996, and 2000 to 2006. Each year, between 62 and 72 plans were
represented in our dataset. In 2005, the 70 plans represented 58
percent of total assets invested in public pension plans nationwide in
2005, and 72 percent of total members.
[16] K. Brainard, Public Fund Survey Summary of Findings for FY 2006,
National Association of State Retirement Administrators, (Georgetown,
Tex.: October 2007).
[17] These findings may be unique to the time period examined (1988-
2005). In other periods, other factors, such as changes to benefits,
may account for more of the change in the funded ratio than the rates
of return on the investment portfolio.
[18] Reports estimate total unfunded liabilities for public pension
plans nationwide between $307 and $385 billion, but the estimates do
not cover all state and local government plans. One study by the
National Association of State Retirement Administrators reviewed the
funding status of 125 of the nation's large public pension plans in
fiscal year 2006 and found total unfunded liabilities to be more than
$385 billion. Another study reviewed state-only pension plans and found
that in 2005, the most recent year for which substantially complete
data was available, total unfunded liabilities for 108 plans were about
$307 billion. Neither study is a random sample of state and local
government pension plans that represents all public plans nationwide.
NASRA Public Fund Survey (2006). This estimate represents 85 percent of
public plan assets nationwide. Wilshire Consulting, 2007 Wilshire
Report on State Retirement Systems: Funding Levels and Asset Allocation
(2007). This study includes only state plans, not local plans.
[19] When a government does not contribute at least the normal cost
plus interest on the unfunded liability (which is an amount less than
the full ARC), unfunded liabilities will increase.
[20] Chris Edwards and Jagadeesh Gokhale. "Unfunded State and Local
Health Costs: $1.4 Trillion." Tax and Budget Bulletin, no. 40 (Cato
Institute: 2006); David Zion and Amit Varshney, "You Dropped a Bomb on
Me, GASB: Uncovering $1.5 Trillion in Hidden OPEB Liabilities for State
and Local Governments," Equity Research, Accounting and Tax (Credit
Suisse: 2007); Brian Whitworth, Igor Balevich, and Jim Kelly OPEB for
Public Entities: GASB 45 and other Challenges (J.P. Morgan: 2005).
These estimates of health care liabilities are limited by their
methodologies. For example, the reports generalize about all state and
local governments' liabilities from a non-representative sample, and
the reports did not consider the variation in actuarial methods and
assumptions in the calculations (See app. I). The studies base their
estimates on actuarial valuations and public reports that have been
performed by some state and local governments in advance of the
deadlines for the new GASB standards. The studies then extrapolate the
findings to calculate a nationwide total for all state and local
governments.
[21] GAO-07-1156, pp. 27-30. As noted in that report, the simulations
of future contribution rates are very sensitive to assumptions about
the growth rate of health care costs and to assumptions about the rate
of return on investments.
[22] Few entries were available from 1998, so we did not use any data
from this year.
[End of section]
GAO's Mission:
The Government Accountability Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting
its constitutional responsibilities and to help improve the performance
and accountability of the federal government for the American people.
GAO examines the use of public funds; evaluates federal programs and
policies; and provides analyses, recommendations, and other assistance
to help Congress make informed oversight, policy, and funding
decisions. GAO's commitment to good government is reflected in its core
values of accountability, integrity, and reliability.
Obtaining Copies of GAO Reports and Testimony:
The fastest and easiest way to obtain copies of GAO documents at no
cost is through GAO's Web site [hyperlink, http://www.gao.gov]. Each
weekday, GAO posts newly released reports, testimony, and
correspondence on its Web site. To have GAO e-mail you a list of newly
posted products every afternoon, go to [hyperlink, http://www.gao.gov]
and select "Subscribe to Updates."
Order by Mail or Phone:
The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or
more copies mailed to a single address are discounted 25 percent.
Orders should be sent to:
U.S. Government Accountability Office:
441 G Street NW, Room LM:
Washington, D.C. 20548:
To order by Phone:
Voice: (202) 512-6000:
TDD: (202) 512-2537:
Fax: (202) 512-6061:
To Report Fraud, Waste, and Abuse in Federal Programs:
Contact:
Web site: [hyperlink, http://www.gao.gov/fraudnet/fraudnet.htm]:
E-mail: fraudnet@gao.gov:
Automated answering system: (800) 424-5454 or (202) 512-7470:
Congressional Relations:
Ralph Dawn, Managing Director, dawnr@gao.gov:
(202) 512-4400:
U.S. Government Accountability Office:
441 G Street NW, Room 7125:
Washington, D.C. 20548:
Public Affairs:
Chuck Young, Managing Director, youngc1@gao.gov:
(202) 512-4800:
U.S. Government Accountability Office:
441 G Street NW, Room 7149:
Washington, D.C. 20548: